How to Invest in Real Estate with Little Money
One of the biggest challenges for people who want to invest in real estate is that buying properties requires a lot of money to get started. So, how can someone with little money invest in real estate?
If you want to start investing in real estate but don’t have a lot of money, your best option is to avoid physical real estate altogether. Investing in Real Estate Investment Trusts (REITs) is a great way to start investing in real estate with less than $100.
This post acts as a guide for people who want to invest in real estate but don’t have a lot of money and aren’t interested in taking on vast amounts of risk.
You don’t need to own physical real estate
With its combination of monthly income and potential for price appreciation, there is a lot to like about investing in real estate. One of the downsides of real estate is that it takes a lot of money to buy a property. That makes it less accessible for people who are starting and may not have a 20% down payment plus closing costs available in cash to buy a property.
One of the most commonly Googled real estate investing questions is “how to invest in real estate with no money and bad credit?”
If you have no money and bad credit, you absolutely should not be trying to buy physical real estate. Real estate is a physical asset which requires constant repairs and expenses. It’s simply too risky to purchase a property without a pile of cash available to cover these expenses.
An alarming number of real estate blogs advocate incredibly risky strategies to invest in real estate without a lot of money, such as taking out a Home Equity Line of Credit (HELOC) on your primary residence to come up with a down payment on an investment property.
While that might help you come up with the money for a down payment, it’s an incredibly reckless idea for two reasons.
Using a HELOC to come up with your 20% down payment and getting a second mortgage to come up with the other 80% of the price of the property means you bought the property using 100% debt. You have just leveraged yourself to the hilt.
A HELOC is a loan against your home. If you default on a loan against your home, you put yourself at risk of losing your home. If the investment property goes south, you could be putting your home in jeopardy.
Unless you are comfortable with that incredibly high amount of risk, it’s not realistic that you will be able to buy an investment property with only a little bit of money.
However, that does not mean you can’t start investing in real estate.
The smart way to invest in real estate with less than $100
Just because you can’t afford to buy physical real estate, does not mean you can’t become a real estate investor. You can easily invest in Real Estate Investment Trusts or REITs for short. REITs allow you to start investing in real estate even if you only have a few dollars to invest.
What is a REIT?
REITs are companies that invest in commercial real estate. REITs invest in a variety of Real Estate projects that most regular people would not have the capital to invest in such as:
Large apartment complexes
Factories, warehouses, and other industrial buildings
For every type of property, you can think of, there is likely a REIT that invests in it.
How to buy REITs
Generally speaking, there are two types of REITs
Personally, I have never invested in private REITs, so for the remainder of this article, when I talk about REITs, I am referring to public REITs.
They are called public REITs because they are publically traded on the stock exchange where investors can purchase shares of REITs in the same way you would buy shares of Apple, Amazon, or any other publically traded company.
So, are REITs the same as any other stock?
While they are publically traded the same as any other stock, REITs have unique characteristics that make them different from many other stocks.
The first and most obvious difference is that REITs only invest in real estate assets, whereas other publicly traded companies are free to invest in whatever they please.
The most crucial difference between REITs and other stocks is their distribution requirements. REITs are required by law to pay 90% of their taxable income in the form of shareholder distributions each year. This is in stark comparison to traditional stocks, which are free to set their own dividend payout policy. Many stocks choose not to pay out a dividend at all and instead reinvest profits to grow the business.
The 90% payout requirement makes REITs an attractive proposition for income-seeking investors. However, the income produced from REITs is not the (only) reason I like them.
Why I invest in REITs
When discussing why it’s not a rational approach for investors to chase dividends, I stated that the only thing a rational investor should be concerned with is the total return on investment. Total returns refer to an increase in the share price + dividends.
The simple reason I invest in REITs is that they have historically had a fantastic total return. A few facts from Canadian portfolio Manager Ben Felix on REIT returns.
From 1989 to 2019, the S&P Global Reit Index returned 9.24% on average.
In the same period, the MSCI all-country world index, which tracks the global stock market returned 7.77% per year on average.
The correlation of these indexes was 0.513.
Both of these figures are in Canadian dollars.
Amazingly, the historical total returns on REITs have outperformed that of the general stock market. What is even better is that since these asset classes have had a low correlation, meaning their prices do not always move in the same direction or magnitude, there appears to be a diversification benefit of adding REITs to a portfolio.
Beyond the rational aspect of receiving an exceptional return with a low correlation to the stock market, I also like investing in REITs because it satisfies my desire to invest in real estate.
Like many other people in North America, I have a bias that favors investing in real estate. For reasons that are not entirely rational, I just feel good owning real estate.
Investing in REITs allows me to scratch that real estate itch without investing hundreds of thousands of dollars and taking on an additional mortgage to buy physical real estate.
Why I prefer REITs to physical real estate
While I do own physical real estate, moving forward, all of my investments in real estate will be through REITs. I am choosing to do this because REITs solve there three most significant problems of investing in physical real estate.
Diversification. Rather than investing in one property, in one city with physical real estate, REITs allow me to invest in thousands of different properties in different geographical locations.
Liquidity. Selling a physical property takes a long time (often months) and a lot of money through paying a real estate agent, lawyers, and other fees. In addition to that, selling physical real estate is an all or nothing proposition. I can’t sell half of a property. All of those issues go away with REITs, where I can instantly sell anywhere between 0%-100% of my investment in REITs for only a few dollars in fees.
The time required to manage properties. If you own and operate your own rental properties, that involves a lot of work to manage them. You can pay a property manager to help with those duties, but there is no escaping the fact that owning physical real estate requires a time commitment. REITs, on the other hand, are a truly passive investment.
Are REITs considered their own asset class?
At this point, you might be thinking that REITs sound entirely different than traditional stocks and real estate. One of the more interesting debates around REITs is if they should be considered to be a separate asset class than stocks.
If REITs are, in fact, a separate asset class, that will provide you greater diversification in your investment portfolio by adding it to your existing positions of stocks and bonds.
So, are REITs a distinct asset class from stocks? It depends on how you look at it.
In 2018, Peter Mladina published a paper titled “Real Estate Betas and the Implications for Asset Allocation,” in which he refers to REITs as a hybrid asset class. On the other hand, his analysis shows that the exceptional returns on REITs can be explained by the same factors that explain the returns of small-cap value stocks and high yield bonds.
Speaking strictly from a portfolio construction basis, Mladina’s research would suggest that investing in REITs is similar to investing in some combination of stocks and bonds. This makes intuitive since when you think about the potential for price appreciation of real estate (similar to stocks) and the income it generates (similar to high yielding bonds).
REITs are risky
One of the most common misconceptions about REITs is that they are somehow less risky than traditional stocks. While the volatility of REITs has been slightly lower than stocks, make no mistake investing in REITs involves a high degree of risk.
Returning to Mladin’s research, he also pointed out that since investing in REITs is an investment in one sector of the economy (real estate), it exposes them to idiosyncratic risk. Meaning REITs are exposed to the specific risks facing the real estate sector of the economy. If you think about the last two recessions, it hit different aspects of the real estate sector very hard.
In 2020, as people began sheltering in place at home, many parts of the real estate sector were hit hard. In particular, retail, shopping malls, and office buildings.
The financial crisis of 2008/2009 was triggered in the residential real estate mortgage market.
In both cases, real estate and REITs were hit hard. REITs are risky assets and can be just as volatile as stocks with the additional caveat that they expose investors to the idiosyncratic risk of the real estate sector.
How I invest in REITs
Another misconception about REITs is that many compare investing in an individual REIT as being the same thing as investing in a “mutual fund for real estate.” Someone making this argument would point out the similarities between individual REITs and mutual funds.
Both employ a manager to choose the assets to invest in.
Both provide greater diversification by investing in a large pool of assets.
To be clear, investing in individual REITs is not the same as investing in a mutual fund or index fund. Investing in individual REITs is no different than investing in individual stocks.
225 REITs trade publicly In the U.S alone. Many of these REITs specialize in investing in a specific type of property, for example, apartment buildings or office buildings.
Investing in an individual REITs opens you up to further idiosyncratic risk. If you invest in a REIT that specializes in buying office buildings in three different cities, you are exposed not only to the risk in the entire real estate market but also the risk of the specific office building sector and the specific economic conditions in thee three cities that REIT invests in.
In the same way, I buy index funds when I invest in stocks and bonds; I buy index funds to invest in REITs. Investing in a REIT index fund removes the city and industry-specific risks of individual REITs. Why buy one or two specialized REITs when I can own them all?
Where I invest in REITs
Finally, another important consideration is where to hold investments in REITs. Another crucial difference between REITs and traditional stocks is how the dividends from each investment are taxed.
In Canada and the U.S, dividends from publicly traded domestic companies are given preferential tax treatment.
REITs, on the other hand, are taxed as regular income. They receive no preferential tax treatment.
For that reason, I only invest in REITs in my retirement and other tax-sheltered accounts. Investing in REITs in a taxable investment account would be inefficient as I would be paying significantly more in taxes on my investment returns.
You don’t need a lot of money to invest in real estate
While investing in physical real estate requires a lot of money, investing in REITs allows someone with less than $100 to begin investing in real estate.
REITs are companies that buy real estate and payout 90% of their taxable income to their shareholders. You can easily buy REITs in the same way you would buy stocks. Additionally, you can increase your diversification by buying REIT index funds in the same way you would buy an S&P 500 index fund.
REITs have historically provided a strong return while maintaining a low correlation to stocks. However, investing in REITs is investing in one specific sector of the economy (real estate), which exposes investors to idiosyncratic risk.
REITs solve the three biggest problems of investing in physical real estate.
Management time and effort
REIT investors need to know that the dividends from REITs are less tax-efficient than dividends from other publicly traded companies. This means the most efficient way to invest in REITs is through retirement and other tax-sheltered accounts.
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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
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